SMSF Investment StrategiesSharing Simple Strategies for Self Managed Super Funds
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A safe bear market strategy (only if you like the greeks)
In August 2009, I wrote about two strategies that SMSFs can use to profit in a falling market, which is to buy put options or to buy shares in inverse ETFs. The market has been falling for the past few weeks. Both these strategies can work well if the market continues to fall but you could lose up to 100 percent of your investment in these instruments if the market decides to turn around and shoot up again like it did after the 10 percent correction in January 2010.
I have been bearish since late 2009. In November 2009, I bought some shares in RWM, an ETF that has an inverse correlation to the Russell 2000 index (RUT) which would profit if RUT falls. Of course RUT went up more than 20 percent instead in the next few months, causing my shares in RWM to fall by the same amount. Although I still believe that the market would eventually come down, I closed that position when it hit my pre-determined stop loss of 20 percent.
Since then, I have replaced my RWM position with a much safer position on the RUT using an options strategy which will permit me to profit if I am right, but limit my loss if I am wrong. The risk to reward ratio is also a lot more attractive. The strategy involves buying and selling a combination of option spreads and you will need a good understanding of option pricing before you embark on doing these types of trades. Option prices are affected by a few elements such as delta (price of underlying), theta (time decay) and vega (volatility) which are collectively known as “the greeks”. Understanding the option greeks is critical to managing these positions properly. Below is the profit and loss graph of this position. The white line shows the projected profit and loss in a month’s time. If RUT falls by 10 percent from the current price of 682, my profit should be around $1,781 which represents a 20 percent return as the cost for this position is around $8,500. If RUT falls more than 10 percent, my profit continues to increase. The position gets more profitable over time and the green line shows the maximum profit of $9,400 which is a 110 percent return if the price of RUT falls within my “sweet spot” . If I am wrong and RUT goes up, my loss is limited to about 7 percent.
This options strategy also allows you to make adjustments to “lock in” profits along the way so you will not lose unrealised gains if the market suddenly does a U turn. If managed properly, the position can be turned into a risk free trade as shown in the graph below. The green bar on the right is now above zero, which means you cannot lose money even if the market moves against you.
This is a complex options strategy and requires a solid understanding of options so it may not be suitable for all investors. The reason for this article is to demonstrate that using non-traditional investment methods, there is greater flexibility and opportunity available to investors. I have been hesitant to talk about complex options strategies on this blog before because until recently, I have not found any options strategies that I feel are safe enough, which I would feel comfortable investing myself with funds meant for my retirement. I have been trading options for over 5 years. In good years, I have been able to generate returns of 40 percent per year but I did lose quite a lot of money in volatile times like October 2008.
A month ago, I decided to sign up with San Jose Options, a US based options mentoring company who teach much safer strategies like the one shown above and they teach students using live trades. A few weeks after I started trading these strategies, we had some of the most volatile market conditions which included the DOW falling 1000 points in one day and then bouncing a few hundred points in the next few days. The model portfolio only suffered a small 3 percent draw down after the May 6 debacle but within days my mentor was able to come up with adjustments to the strategies to protect ourselves better in the event of another debacle. Other students who were only doing the safer style trades said they were not hurt by the huge market moves.
These strategies currently can only be done using US options as the Australian options market simply does not have enough liquidity and our brokers do not have the trading platforms to enable us to do these complex trades.
Traditional investment methods like buying and holding stock can only make money if we are in a bull market. If you believe as I do that the bear market that started in 2007 is about to resume and remain with us for the next few years, then you will need to learn new investment strategies that can enable you to profit in a bear market. If anyone is interested in learning more about these strategies, check out the San Jose Options website . Feel free to email me at Christina@sli-smsf.com if you want to discuss further about whether these strategies are suitable for you. Readers of this blog get a special $50 discount so do let me know if you are interested to sign up for the courses.
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